Frequently Asked Questions on Manager Research and Due Diligence

The goal of this piece is to provide advisors with real world tools and techniques they can apply to their practice today.

Many advisors rely on research and reporting tools to inform their decision making. How does Wilshire’s manager research team approach the investment manager due diligence process?

Wilshire has a dedicated manager research team who meets with, analyzes, and recommends money managers and their funds. Ultimately, our recommendations result from the expertise and market experience of our skilled professionals who make qualitative judgments using a consistent evaluation process that allows us to effectively compare distinctive managers. Our manager research team is armed with databases and reporting tools, such as Wilshire CompassSM, our proprietary database that captures quantitative and qualitative information from managers across the globe. We don’t charge managers to be a part of this service, so no matter how small or large a firm, everyone can submit their information. This provides a great launching pad for our research team to begin their work.

Once a manager has loaded their data into our database, our research team can use Wilshire’s proprietary risk and attribution tools to slice and dice the portfolio as they see fit, all before even setting foot in the room with a manager. We also use an internal database to house our research so that we can capture all of our analysis over the years, building a library that spans products, asset classes, and firms.

Advisor Tip: Many advisors don’t have the ability to conduct in-depth manager due diligence on their own. If you are in the market to purchase a research and reporting tool, it’s important to look for a tool that provides both quantitative data and qualitative insights.

Why is the qualitative process so important?

Simply put, you cannot pick managers based on past performance. Understanding the drivers of performance and setting expectations going forward is critical to uncovering opportunities that seek to generate alpha for clients. Additionally, relying on quantitative information alone will not help you separate the good from the lucky. Wilshire’s manager research process looks for characteristics that cannot be measured quantitatively, aspects which we can only gather by meeting with and talking to investment professionals and learning their strengths and weaknesses. For example, an experienced investment team may have generated excellent returns in the past, but without conducting qualitative due diligence to asses the quality of the firm, investment team, and repeatability of the investment process, it is difficult to judge how they are likely to perform in the future.

Advisor Tip: The heritage and history of a manager, as well as their team structure, compensation, and more, are just as important as quantitative data when assessing a manager.

The due diligence process can be very detailed, with a lot of information to consider when looking at a manager. What’s the best way to keep track of it all?

Wilshire’s proprietary database is where we collect all of our quantitative and qualitative information from managers. The database includes Wilshire’s due diligence questionnaires, which help capture key information directly from the manager, along with our analysis, meeting notes, other materials the manager provides, and finally the outcome of our detailed process – the written evaluation and rating. All of these become evaluation tools that allow us to go back and understand how a manager has come through our process, and our thinking at various stages of getting to know the manager; they also help us keep track of our overall opinion on them over time. Wilshire conducts over 1,200 manager meetings per year, so maintaining a structured, centralized database for our intellectual capital is imperative.

Advisor Tip: Having a due diligence questionnaire or evaluation in place for each manager you review can help deepen your understanding of their firm, strategy and process, as well as providing an historical record of your research. The more you can create a structured research practice with detailed processes in place, the more value you create for your practice.

How important is the tenure and stability of a portfolio management team?

High turnover can be a red flag because if portfolio managers and analysts are constantly revolving through a firm it can increase the chance of process and philosophy drift over time, may disrupt the cohesion of the team, and can create a loss of institutional memory or knowledge. Understanding the history of a team, its current makeup, how they are compensated and rewarded for success, and how they fit into the broader organization are key aspects one should consider in this part of the due diligence process.

Advisor Tip: “Does the strategy have a stable investment team?” and “What is the structure of the broader investment organization (independent or private vs. large institution)?” are important questions to ask during the due diligence process.

Why is risk management important in the due diligence process? What is important to consider when looking at the risk management framework a manager employs?

No matter how good a manager is at picking winning stocks, it is critical that they understand how all their different positions interact with one another. During periods of market stress, managers often find it is their unintended “bets” that cause the most pain. The years when simply “knowing my companies” passed for acceptable risk management are long gone. Various factors can influence performance, therefore it is important to understand how the manager defines risk, measures risk, analyzes risk, and makes portfolio construction decisions as a result. When we meet with managers we expect them to understand and be able to explain what risks they take and why.

Advisor Tip: Managers must diligently manage their risk exposures. When speaking with a manager, ask them for details about their risk management process and seek examples of changes they may have made to their portfolio based on risk analysis.

How should I frame performance expectations for a given manager?

The first and most critical step in understanding performance expectations is to gain a complete and thorough understanding of the manager’s philosophy and process. Then, based upon that information, we can ascertain which market environments we believe are most conducive to the manager acheiving strong relative performance. Wilshire’s many years of experience correlating manager philosophies and processes to actual market outcomes come into play here. Once we determine our opinion of more and less favorable market environments for a given manager, we then ask the manager when they think they are most likely to outperform and underperform. If there are major differences between what we think and what they say, we explore why. Finally, based on the portfolio characteristics we observe over time, we can set reasonable expectations for performance going forward. For example, a value-oriented manager who generally exhibits a beta of > 1.0 would be expected to preserve capital in down markets, while underperforming in strong up markets.

Advisor Tip: A solid understanding of when a manager is likely to outperform and struggle is imperative in setting expectations with your clients. As you execute your due diligence process, ask the manager in what markets they would expect to outperform and underperform.

What are the most important factors Wilshire looks for as they get to know a manager? What truly indicates a manager has a structured and solid process?

Ultimately we are looking for a manager’s process to be rigorous, repeatable, and consistent. Superficial research and valuation work will not help managers outperform their peers or benchmarks, nor will a process that is inconsistently applied. Beyond that, what are all managers essentially trying to do? They want to identify an inefficiency or anomaly in the market and exploit it. We like to see a repeatable idea generation process, a research methodology that is thorough enough to yield valuable information, a valuation process that makes sense relative to the asset class, a risk management framework that helps avoid unseen pitfalls, and a comprehensive approach to determine when to exit securities (sell discipline). The last factor is one that is overlooked by many due diligence practitioners and can often mean the difference between outperformance and underperformance. While it is impossible to always select the top performing manager in any given quarter or year, we believe that focusing on managers whose process is repeatable and consistent best positions us to invest in managers who are able to successfully execute their strategy over the long term.

Advisor Tip: Feeling confident that a manager has a sustainable and repeatable process in place is crucial before investing.

What are some common red flags to look for that might be an indication of a manager straying from their discipline?

There are many red flags that can and should alert investors that a manager is straying from their mandated discipline. Here are a few examples of things that may be indicative of a deviation on the part of the manager that may lead to adverse or unintended results:

A meaningful increase in the number of holdings can be the result of asset bloat, and may be an early warning sign the manager is having difficulty implementing their strategy with a larger AUM base.

Holdings-based analysis can provide good insight into a manager’s consistency or lack thereof. For example, is a value manager initiating positions in more growth-like, expensive names, or is a U.S. equity-focused manager purchasing non-U.S. stocks?

Paying close attention to the capitalization of a fund and if it drifts up or down is an important monitoring tool as well. For example, some small cap managers may let too many winners run and not harvest gains, or start purchasing more mid-cap names as the size of the fund increases.

For fixed income managers, keeping a close watch on duration, sector, and credit quality exposures in the portfolio and how they change over time can signal a deviation from the stated mandate or philosophy.

If you know a manager’s process is more defensive or capital preservation-oriented, outsized excess outperformance in a strong up market could be a red flag. If a manager expects to do well when small caps are in favor, but has lagged in a small cap driven recovery rally, it may warrant additional due diligence. Also, if performance is directionally deviating from the peer group this could be an indication of some sort of shift in the manager’s process.

Advisor Tip: A good balance of common sense, careful monitoring, and thorough due diligence can help identify potential problems early, before they translate into poor or unintended performance. Ultimately, none of these red flags either individually or even in combination are necessarily warranting of an immediate sell, but should lead to a more detailed conversation with the investment team to understand the rationale behind the changes.

Important Information
This material is for information purposes only. Wilshire Funds Management (“WFM”) is a business unit of Wilshire Associates Incorporated (“Wilshire®”). WFM delivers Wilshire Advisor Solutions, which include models designed to provide a broad range of outcome-oriented investment portfolios for advisors to use with their clients. WFM uses mathematical and statistical investment processes to allocate assets, select managers and construct portfolios and funds in ways that seek to outperform their specific benchmarks. Past performance is not indicative of future results and processes used may not achieve the desired results.

This material is intended for informational purposes only and should not be construed as legal, accounting, tax, investment, or other professional advice and may not be disclosed, reproduced or redistributed, in whole or in part, to any other person or entity without prior written permission.

This material represents the opinion of WFM as of the date indicated. WFM assumes no responsibility to update any such opinions.

Wilshire® is a registered service mark of Wilshire Associates Incorporated, Santa Monica, California. All other trade names, trademarks, and/or service marks are the property of their respective holders.

This information is for information purposes only. This information represents the current opinion of the firm. Information herein which has been obtained from third parties are based on sources believed to be reliable. Wilshire Funds Management does not represent that such information it is accurate. Statistical data contained herein are as of the dates noted and such information should not be relied on or be the basis for an investment decision. Past performance is no guarantee of future results. Investing involves risk including loss of principal.